Feb. 3 — The Securities and Exchange Commission proposes
exempting small companies and startups raising capital under Regulation A from
state blue sky laws.
While the business community says the move will
tear down a needless obstacle to capital building and job creation, state
regulators say they are “dismayed” and “shocked” by what they consider to be
an anti-shareholder plan.
“We urge the Commission to remove these
provisions from the rule,” William Galvin, Secretary of the Commonwealth of
Massachusetts, said in a Dec. 18, 2013, letter to the SEC.
The SEC is accepting comment
letters from the public on its proposed Section 3(b)(2) of the Securities Act of 1933,
which would amend Regulation A, until March 24.
The amendment is
referred to as Regulation A-Plus, and it is designed to make it easier for
smaller companies to raise capital, Katherine K. DeLuca, an associate in the
Richmond office of McGuireWoods LLP, told Bloomberg BNA Jan. 30.
it easier, Regulation A-Plus would preempt state laws that regulate the
offering of securities made within their borders.
The SEC has said that
without broad federal preemption, state blue sky laws would remain an obstacle
to Regulation A's popularity, DeLuca said.
As proposed in December,
Regulation A-Plus will serve as a useful alternative to Regulation D in the
eyes of many issuers seeking capital. “They will provide a meaningful choice to
companies depending on their needs and goals,” DeLuca said.
mandated the changes to Regulation A as part of the Jumpstart Our Business
Startups Act of 2012. It directed the SEC to adopt rules exempting offerings of
up to $50 million in securities annually from the registration requirements of
the Securities Act of 1933. Currently, Regulation A exempts offerings of up to
$5 million over a rolling 12-month period.
The SEC's Regulation A-Plus
not only addresses the money threshold, but also includes issuer eligibility
rules, content and filing requirements for offering statements, and ongoing
reporting requirements for issuers.
N. Feldman, an attorney and partner in the New York office of Richardson &
Patel LLP, told the SEC in a Jan. 15 comment letter that one main reason Regulation A has
almost never been used was the “delay, cost and uncertainty” of divergent state
review of offerings caused by state blue sky laws.
In some cases, blue
sky laws conflict with SEC disclosure standards and are based on arbitrary
merit standards, he said.
“The preemption (of state securities
regulation) will create a major incentive for companies seeking a public
trading stock to utilize Regulation A-Plus, and the states can continue to
play a key role in enforcement and regulation of market intermediaries,” he
Regulation A has not been the most popular route for companies
looking to raise capital. The SEC reported only 19 Regulation A offerings,
involving $73 million, from 2009 to 2012, DeLuca said. In contrast, the SEC
reported 27,500 offerings under Regulation D, amounting to $25 billion, and
373 registered offerings, totaling $840 million dollars, from 2009 to 2012,
“Regulation A offers some desirable features for issuers
but also has some significant limitations that would explain its recent
unpopularity,” DeLuca said during a Jan. 28 McGuireWoods webcast, “SEC
Compliance and Disclosure Update.” “One of its biggest is its size
limitation” of $5 million.
Unlike Regulation D offerings, Regulation A
does not limit who may make purchases, and the securities sold are not
restricted, which means they are freely tradable.
Regulation A also
does not prohibit general solicitation or advertising, and “issuers are
allowed to test the waters in order to gauge investor interest before the
offering is launched,” she said.
“We urge the Commission to
remove these provisions from the rule.”William Galvin Secretary,
Commonwealth of Massachusetts
Regulation A has always been
intended to serve as an easy means for small companies to raise limited
capital, but it has not successfully served that role, especially in recent
years, she said.
As part of Regulation A-Plus,
the offering threshold was raised to $50 million from $5 million over a
rolling 12-month period. Every two years the SEC must review that limit and
increase it if appropriate. If the SEC decides not to increase the offering
limit, it must explain to Congress why. The first review is to be completed by
April 5 of this year.
The JOBS Act also preserves some of Regulation A's
most desirable features, DeLuca said. The statute dictates that Regulation A
offerings will continue to be public offerings, that the securities sold are
not restricted and that issuers are allowed to test the waters, she said.
The statute adds a new requirement that Regulation A issuers must file
annually audited financial statements with the SEC. Otherwise, the JOBS Act
left it to the SEC to mandate the other terms and conditions of Regulation A
through its rulemaking authority.
“The SEC took aggressive steps to
make Regulation A a truly workable option for issuers,” DeLuca said.
Regulation A-Plus creates two tiers of
offerings. Tier 1 resembles current Regulation A, but can include up to $1.5
million in securities for the account of selling security holders. Tier 2
allows for offerings up to $50 million over a 12-month period
2 offerings, the proposed rules include several new requirements designed to
protect those who purchase shares in those larger offerings. They include
audited financial statements, which will be required of Tier 2 initial
In the past, issuers did not have to provide audited financial
statements unless they already had them prepared for other reasons. This will
remain the case for Tier 1 offerings.
The proposal also includes a cap
on the amount of securities an investor may purchase through a Tier 2
offering. The cap would be set at 10 percent of the greater of the investor's
annual income or net worth.
The rules also would allow the issuer to
rely on investor representation of compliance, unless issuer has reason to
believe investor's representations are false, DeLuca said.
Tier 2 offerings will be subject to new, ongoing reporting
obligations, including an annual Form 1-K, which asks for much of the same
information as in a 10-K.
Issuers also will need to file an interim
report on Form 1-SA, which reports on the issuer's first six months of its
first reporting year, DeLuca said. It is much like a 10-Q. In addition,
issuers will be required to file Form 1-Us, which will have a four-day
deadlines and serve much the same purpose of an 8-K.
requirements will remain in place for at least one year after the offering is
qualified and for as long as the offering is ongoing. Both tiers must report
on the completion of the offering.
new reporting requirements in Tier II offerings allow investors to have
regular and current information on important developments while easing some of
the burdens of full reporting.”David N. Feldman Partner, Richardson &
“The SEC points to all these protections in order
to justify preempting state blue sky laws,” DeLuca said. “Under the current
rules, all Regulation A offerings are subject to state blue sky laws.”
In addition to going through the federal filing and
review process, which took an average of 228 days, Regulation A issuers were
subject to review in any state in which they wanted to offer securities,
All states conduct their own disclosure review and unlike
at the federal level, states also analyze the fairness of the offering to
investors and compare it to their own merit standards, DeLuca said.
Issuers must address the state's merit and disclosure concerns before the
offering may proceed, she said. That is time-consuming and expensive, “as it
leads to more and more legal and accounting fees,” she said.
Regulation A-Plus proposal exempts all Tier 1 and Tier 2 offers and all Tier 2
purchases from blue sky laws by expanding the definition of “qualified
purchaser,” DeLuca said.
The SEC proposed that the term “qualified purchaser” be
defined to mean an accredited investor as defined in Rule 501(a) of Regulation
D, saying, “We believe that it is appropriate to equate qualified purchasers
with accredited investors because the regulatory and legislative history of
both terms are based upon similar notions of the financial sophistication of
investors and accredited investor is a long-standing concept familiar to the
small business community and other industry participants.”
Mike Liles Jr., a shareholder and member of the corporate
finance practice group of Karr Tuttle Campbell of Seattle, Wash., expressed
criticism of this use of “qualified purchaser” in a Jan. 17 comment letter to the SEC.
Offerings under Section
3(b) are aimed at unsophisticated retail investors, so more limiting language
is needed, he said. The lack of any language akin to “sophisticated investors,
capable of protecting themselves” in the proposed definition is “unexpected and
questionable,” he said.
“In effect, the use of the definition of
‘qualified purchaser' merely as a tool for effecting preemption of state
regulation without providing any substantive element of investor protection, is
jarring in this context and would not appear to be what Congress intended in
enacting Section 401(b) of the JOBS Act,” he wrote.
Liles warns that if
the “qualified purchaser” language is kept and adopted, as is, it might not
withstand legal challenge.
Such a possibility “might discourage efforts
by regional investment bankers from committing the significant resources
required to properly service small business public offerings until the Section
3(b) Proposal's ability to withstand a challenge has been definitively
decided by the courts,” he said.
The North American
Securities Administrators Association, an organization that advocates for
pro-investor policies, is fighting the SEC's blue sky law preemption
Andrea Seidt, the association's president, said in a message on the NASAA website that state oversight of
Regulation A offerings is “essential” given the risky nature of investments in
“However, we recognize the need to change some of our
longstanding policies,” she wrote.
The NASAA is consulting with a task
force of the American Bar Association to develop a uniform review protocol for
states to adopt, she said. Under the new protocol, lead examiners would handle
the review of a registration application and work with the issuer to try to
remedy any deficiencies within a set time frame.
The organization is
also planning to build an electronic filing platform that companies and states
would use, Seidt said.
Calls to NASAA for comment were not returned.
The lower-tier over-the-counter trading markets for
stocks, such as the Pink Sheets Market and the OTCBB, which list stocks of
small public companies, are notorious for providing insufficient information
to the public and for fraudulent and abusive practices, Secretary Galvin said
in his letter to the SEC.
Rule 506 offerings, under Regulation D,
already give issuers a way to raise unlimited amounts of money with no
substantive regulatory review at any level, and they are the No. 1 source of
state enforcement complaints for fraud, Galvin said.
The plan to
preempt state review for Regulation A offerings must be scrapped, Galvin
“The states have tackled preemption battles on many fronts, but
never before have we found ourselves battling our federal counterpart,”
Galvin said in his comment letter to the SEC. “Shame on the SEC for this
anti-investor proposal. This is a step that puts small retail investors
unacceptably at risk.”
Regulation A offerings are often local in
character, he said.
“If that pattern continues, Regulation A-Plus
offerings will also be sold substantially in the issuers' home states and in
local-area markets,” he said. “For this reason alone, it is crucial for the
states to have a role in overseeing these offerings in order to protect their
The SEC's preemption provision “contravenes Congress' express
intent on this issue,” he said.
“When the Regulation A-Plus legislation
was under consideration, Congress considered, but ultimately rejected,
language that would preempt state review of those offerings,” he added. “NASAA
and the states tracked this legislation and successfully urged that state
authority to review these offerings should be maintained.”
Even if the
NASAA's new protocol for a multistate review process is developed, the
preemption of state blue sky review is needed if Regulation A is to be
successful, Feldman said in his letter.
“The new reporting requirements
in Tier II offerings allow investors to have regular and current information
on important developments while easing some of the burdens of full
reporting,” he said. “In addition, audited financial statements meaningfully
improve investor protection and confidence, as do the proposed bad actor
An owner of a
self-storage business in Missouri, David B Kolstedt, voiced his support for
the SEC proposals in a Jan. 5 comment letter. He said he has three profitable
locations and would consider expanding his business under a revised Regulation
The $50 million limit would allow him to add about a dozen
properties, he said.
“We have already added three jobs to the economy
within the limits of our own personal investment and could probably add five
times that with additional investment,” he said. “If the JOBS Act is about
adding jobs through a strengthened economy, then this is a win for the country
and the company.”
To contact the reporter on this story: Che Odom in
Washington at email@example.com
To contact the editor responsible
for this story: Kristyn Hyland at firstname.lastname@example.org
The proposed Regulation A-Plus is available at http://www.sec.gov/rules/proposed/2013/33-9497.pdf.
Comment letters on the SEC's proposal are accessible from http://www.sec.gov/comments/s7-11-13/s71113.shtml.
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